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Numbers manipulator describes Enron's descent

Andrew Fastow, former Enron CFO and convicted fraudster, gives his first full-length interview after exiting prison

March/April 2016

ByEmily Primeaux; Photo by George Brainard

Nearly 15 years ago the actions of Enron's C-suite executives led to the company's demise. In this interview with Andrew Fastow, former Enron CFO, read how the toxic corporate culture and his rationalizations behind "finding the loopholes" led to one of the largest and most well-known cases of corporate fraud and corruption.

"The inmates in prison camp were easier to get along with than Enron executives," says Andrew Fastow during a sit-down interview with Fraud Magazine at the 2015 ACFE Asia-Pacific Fraud Conference in Singapore, at which he was a speaker. "People [at Enron] were incentivized to do the wrong thing and senior management set very bad examples by the decisions they were making. … We had senior executives, especially myself, who were doing deals that sent a bad ethical message."

As the former CFO of Enron Corporation, Fastow's role in this toxic corporate culture has forever cemented the fate of the multibillion-dollar American energy, commodities and services company — Enron's bankruptcy in 2001 wiped out $40 billion in stock market value and led to the collapse of its well-known accounting firm, Arthur Andersen. Fastow admits that he failed to recognize the implications of his unethical business dealings that led to the company's demise. "I was the gatekeeper," continues Fastow. "I should have been making the tough calls and I didn't. I just abdicated."

Instead of making those tough calls, Fastow helped set up a system of structured financing that gave Enron greater access to capital and made financing less expensive. Eventually the deals morphed into transactions that didn't have economic substance. These transactions kept debts off the balance sheets and made the company appear healthier than it actually was. In reality, Enron misstated its income — its equity value was a couple of billion dollars less than its balance sheet stated. Using "partnership" companies the company had created, Enron masked huge debts and heavy losses from its trading businesses.

Fastow maintains they intended to follow accounting rules and the company's accountants and attorneys technically approved the deals; nonetheless they were misleading. He now calls his machinations fraud. "I always tried to technically follow the rules, but I also undermined the principle of the rule by finding the loophole," he says. "I think we were all overly aggressive. If we ever had a deal structure where the accountant said, 'The accounting doesn't work,' then we wouldn't do those deals. We simply kept changing the structure until we came up with one that technically worked within the rules."

The beginning of the end

Pressure from within the C-suite eventually reached a boiling point. "We only made our numbers many quarters because of the finance group, and there was a lot of pressure to get them done," Fastow says. "There was pressure that other people put on me as well as me putting it on myself. I wanted to do these deals, I wanted to be the hero. That was also my ego, and things like that got out of control."

In the third quarter of 2001, when it became apparent that Enron would finally have to recognize the losses, Kenneth Lay, Enron's chairman and CEO, refused to issue equity, and the company was downgraded to junk status, which triggered the company's bankruptcy. Eventually, thousands of employees lost their jobs and saw their pension funds obliterated because a few executives made some unethical decisions.

Many key players were indicted and sentenced to prison. Fastow pleaded guilty to two counts of wire and securities fraud and was sentenced to six years in prison. Lay and Skilling were convicted for conspiracy, fraud and insider trading. Lay died before his sentencing, and Skilling received 24 years and four months, which was later reduced, and a $45 million penalty. His release is scheduled for 2019.

"What I did was wrong and it was illegal, and for that I'm very sorry, very remorseful," says Fastow. "I wish I could undo it."

After serving 4½ years of his sentence, Fastow is slowly easing himself back into the public eye as he tells his story before audiences of college students, business people and fraud examiners. He's also speaking more to the media as he did to Fraud Magazine.

FM: Tell me about your first job out of college. AF: My first job out of college was at The Original Pancake House for six weeks before I was supposed to start my job at Continental Bank in Chicago. When my wife-to-be and I arrived in Chicago, the first thing we did was unpack our TV so we had something to listen to, and there was a newsflash that Continental had failed. So, I went out and started walking down the street until I found a job with The Original Pancake House.

Six weeks later I was able to start at Continental, which was operating during its reorganization. They had … a 2½-year training program where you work in different areas of the bank learning how banks operate. They teach you credit and you get your MBA at night, so I worked and got mine at Northwestern.

FM: How did you come to work for Enron? AF: Long story short — I received a call from a headhunter who'd learned what I was doing at Continental. I was working on a relatively new type of financing and there were very few people in the country doing it at that point in time. He'd learned that I had a connection to Houston, so he put it all together, and that's exactly what Enron was looking for at that time.

FM: Did you start in the lower echelons of Enron or did they bring you in in a high position? AF: No, no, I wasn't brought in at a high level. At Enron each of the operating companies (e.g. a pipeline company, oil and gas company, international development company) had their own businesses and a finance person, and the job of that finance person was to do off-balance sheet financing.

Enron had just set up a trading and finance company, which was headed by Jeff Skilling, and they needed a person to do off-balance sheet financing. And the specific type of off-balance sheet financing they wanted to do was very analogous to what I was doing at Continental Bank — that's why they hired me. But I came in at a relatively low level. It was an operating company, not a corporate level, and I was just a finance guy. About seven years later I became CFO of Enron.

FM: What do you think made you stand out to the executives during those seven years? AF: I think my ability to do structured financing, to finance things off-balance sheet and to find ways to manipulate financial statements — there's no nice way to say it. Like I said at the conference, I was good at finding loopholes; that's a nicer way of saying manipulating the financial statements or being misleading, and I was good at it. I'm not proud of it now, but I was very proud of it at that time.

FM: When you went to work for Enron — and let's focus on when you were in those first positions — what were your first impressions? What did you think about Enron as a company? AF: I thought Enron did kind of questionable accounting. I was hired in November of 1990 and I said to the guys, to Jeff Skilling, that I would like to start January 1 so I could take the month off, spend it with my family — we had a vacation planned. And he said, "No, no, I need you down here immediately; you have to get something off our balance sheet by year-end" … Literally less than 30 days to do a financing transaction. I've never been at the company before, and I hadn't done this particular type of financing.

So, we worked very hard to get the deal done, and on about December 30 we signed all the documents, and the accountants and attorneys approved it, and we were all very happy about it. I didn't think I could get it done, but we got it done.

On January 2, I'm walking down the hall at Enron, and I bump into the head of accounting for this operating company and I made some innocuous comment like, "It sure is good that we got that deal done," and he said, "We didn't really get it done." And I said, "What are you talking about? We signed the documents, I was there." He replied, "Yeah, but the accounting didn't work, so we just decided to throw that into the materiality basket." That meant that we were just going to ignore it.

FM: What did materiality mean in this instance? AF: So, basically it's the accountant saying that even if we don't think it's quite correct, it's small enough that we aren't going to spend any time worrying about that. And I went back to my office, and I was stunned because they told me it worked, and now I'm learning it didn't really work, and I remember thinking to myself, "How could they do that? How could they just ignore it?" At that point I should have just gotten up and walked out and gone back to Chicago or somewhere else. But I didn't, and that was my failing — not Enron's failing, no one else's. Instead I embraced it, and I figured that I'd find ways to be good at it.

FM: Interesting. So those were your impressions, but I'm also curious to know what you think they thought of you when you first came to the company, maybe initially and after these first deals. AF: I can't tell you what was in their heads, but they kept giving me promotions and raises and bonuses.

I was the gatekeeper. I should have been making the tough calls and I didn't. I just abdicated."

FM: So, then what led to the beginnings — the beginning of the end, I guess you could say? What led to the beginning of the structured financing that you spoke about in your session? What led to the beginning of, I guess, the fraud itself? AF: It's a little difficult to say when the fraud started because it's better described as the aggregation of all of these deals, which were each maybe technically correct but also misleading. We created something that was monstrously misleading, but any one of those deals alone wasn't necessarily considered fraudulent. The aggregation of the impact of the deals, however, was fraudulent, so I'm not sure at which point we crossed the line, where it became too big and too misleading. It's a bit of a gray area, but I will say this, and maybe this helps answer the question: When I first started doing these structured financing deals, there was clear economic benefit in doing the deals for the company. It also may be that in addition to the economic benefit, there were financial reporting advantages to doing it. So, the accounting made the company look better, but the underlying transaction had an economic rationale; it made our financing less expensive. It gave us greater access to capital — something like that.

Eventually the deals morphed into transactions that didn't necessarily have economic substance, and that were being done just to be misleading. So, we devolved into doing deals where the intent — the whole purpose of doing the deals — was to be misleading. Again, the deal technically may have been correct, but it really wasn't because the intent was wrong. And I can't pick the exact point when we crossed the threshold, but there are some deals that stand out as being worse than others in that regard.

Now, all of the deals were technically approved by our attorneys and accountants, so if that's your definition of fraud then there was no fraud. I will say to you that I believe there was fraud. It's oversimplifying, but if a fraud examiner is typically looking for compliance with the rules, the problem in Enron's case is that you had compliance with the rules yet you still had fraud. I think the first thing that happened is even though the deals were technically approved — because the attorneys and accountants said we were following the rules — they were nonetheless misleading.

FM: What was the aggregate impact? You say you could look at each individual deal and not see it, but on a bigger scale what was that? AF: A simple way to say it is that Enron was given an investment grade by credit rating agencies, but in my opinion it wasn't close to investment grade. It was a junk credit. So, the aggregate impact of the compliant deals was that they were too misleading. The second issue is that we did these deals because there were economic reasons to do the deals: there was a lower cost of financing, or there were other reasons like preserving a tax credit or transferring risk … there was some good reason. Eventually we were doing transactions just because they altered the financial reporting. So, while the deal may have been technically correct, the intent was not correct at all — that's fraud.

FM: So, for a layperson like myself, or some of our fraud examiners who aren't accountants or auditors, can you explain a little bit of the machinations of structured financing and mark-to-market accounting? AF: Well, it's going to be impossible to capture that in an article. This is what I would say. I wouldn't expect the typical fraud examiner to have enough of an auditing or accounting background to be making determinations whether the accounting is correct. And, in fact, you might conclude the accounting's correct and then where are you? You're back where Enron was. So, it should be other questions that they are thinking about. Like what is the intent of this transaction? Is the intent to be misleading? Or is there some true economic or business benefit for doing this transaction?

FM: Establishing a firm tone at the top is an important practice we teach at the ACFE. What was the tone at the top like at Enron? The media painted executives as greedy and money hungry, but what was your impression of the corporate culture when you started at Enron or as you worked your way up? AF: I think it was a bad corporate culture. People were incentivized to do the wrong things, and senior management, including myself, set very bad examples by the decisions we were making. At Enron, we had the best mission statement and code of conduct and all those things that look great. We had a great human resourcing department that churned this stuff out, but we had an incentive system that incentivized people to do transactions that were good for financial reporting purposes but bad for the long-term value of the company. And we had senior executives, like myself, who were doing deals that sent a bad ethical message.

So, you could tell people to be ethical, have beautifully written statements about company values and all that, but you have a CFO who does a deal that's intentionally misleading to the outside world. You have to remember we hired the brightest, most ambitious young people, and they were smart enough to figure out what the CFO just did. And so, despite your corporate code of conduct and your code of ethics, those people saw that this guy became CFO, and he is incredibly misleading. So they decide, "I'm going to be misleading. I will be misleading to the people I work with and to my customers."

So, what the top does is very important, and they should assume that the people who work for them are smarter than they really believe. It's like every generation doesn't realize their kids are a lot smarter than they are, and can outsmart them whenever they want, and top management should understand that their employees see right through them.

FM: Did you have doubts along the way? Were there times when you got a bit nervous? AF: No, it never dawned on me that what I was doing was illegal. I thought what I was doing was what I was supposed to be doing. I was excited and enthusiastic about these deals. We had parties when we closed deals, and we felt like rock stars. For a bunch of financing and accounting geeks that's as close to rock stardom as you get, so it wasn't like we were hiding in a dark room. We were giving interviews about the deals, having closing parties. We weren't thinking that it was fraud, but I also knew it was intentionally misleading, like a weird dichotomy. I rationalized it by saying, "This is how the game is played," but it was really just a lack of character on my part.

FM: You speak at universities like Tufts, Harvard and Dartmouth. What is the most important thing you tell the students? AF: To develop a few questions that they can ask themselves from time to time — not knowing what their different circumstances will be in the future — that will help keep them within these reasonable boundaries. I'm not sure what those questions are and they might be different for different people, but they should think of generic questions like, "If I own this company and I were leaving it to my grandchildren would I make this decision?" A simple question like that would have caught 99 percent of the fraud that went on at Enron, because the answer would have been "No." This forces you to go through the thought process of legitimizing why you're doing it. What I hope they take away is that at some point they need to pause and think about their actions. I don't try to give them the answer — I am the least qualified person to do that — but if they're thinking about it, that's a step forward.

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By Brandon_Clinefelter_2Fantastic interview, really interesting these years later to hear some of the justifications, and realizations.

By Anonymous

By Anonymous

By J_OsbornExcellent interview. Sad so many people lost their entire pensions and really good companies that were aquired under the Enron umbrella were wiped out due to the fraud and greed. I really feel sorry for the victims who lost their jobs, their life savings and the impact it had on them and their families. They will never recover.

By Emily_PrimeauxThanks Mark. I'm glad you enjoyed the article. And the points you make here are completely on point. There's so much more behind the Enron story and I'm glad that this article at least sheds a little light into the inner-workings of that world. - Emily

By Mark_NigriniWell done. I liked the article. Two points were particularly important to me:
Andy Fastow said that it was difficult to know when the fraud started. Unlike employee embezzlement schemes like the Nathan Mueller fraud which started with an $1,100 check, I do believe that financial statement frauds don't have a formal starting date. They slowly change from a liberal interpretation of the rules to outright false reporting.
Andy Fastow commented on the toxic tone at the top. He's right. To read more about that tone you could read either of the two Enron books (key words in the titles are "conspiracy" and "smartest guys") that go into detail about that tone. That toxic tone led to more than just financial statement fraud, each of those books talks about how the Enron traders gauged the California electricity market and that one sentence of "burn baby burn" would only be said by a trader who felt that those sentiments were OK and tolerated by management.